Pervasive Losses In Global Financial Markets, US Treasuries Signal Rising Risk of Recession

``How, exactly, is enslavement won? Through a combination of fabricated “crises” and an insidious phenomenon known as “gradualism.” Create the crisis of your choice — global warming, education, Big Oil price gouging, home foreclosures … ad nauseam — then milk that fabricated crisis nonstop until gradualism is able to take hold and convince the brain dead that the only solution to the crisis is for government to step in and pass more laws to save us from imminent peril.” –Robert Ringer

AFTER two rate cuts (75 basis points), the opening of the discount window (including lowering of its rates), changing of some lending rules such as exempting banks to lend to broker subsidiaries and the widening of the eligibility of collateral acceptance and the injection of liquidity via repos and Federal Home Banks, where the US Federal Reserve appears to have utilized a panoply of monetary tools, including the unconventional ones, to cushion the impact of the housing recession triggered credit crisis, yet such dislocation continues to ricochet throughout the global financial markets.

Interest rates alone reflects on the recent stains where the “TED” spread or the difference between three-month US Treasury bill yields and Libor, the London interbank offered rate soared to record levels! We are thus witnessing a frenetic “flight to quality” in terms of a massive rally in US Treasuries, as shown in Figure 1.

Figure 1: stockcharts.com/ Ivan Martchev: Collapsing Yields of 10 Year Notes!

The last time US treasuries encountered such a colossal move was during the Nasdaq bubble implosion in 2000 that ushered in an economic recession. The blue horizontal arrow points to the closing prices of US the T-Note yields last Friday.

Don’t forget during this period, the US Federal Reserve slashed its Fed rates from 6% to 1% until mid 2003 in order to mitigate the economy’s deterioration but to no avail. Instead the ocean of US dollars generated consequent to such intervention has spawned a new monster; a US housing bubble buttressed by exploding leverage in terms of new financial instruments. Derivatives have now reached $516 trillion during the first half of 2007 (Bloomberg). And some of these are seen unraveling today.

Hence, the behavior of the US Treasury markets, relative to the speed and degree of its decline, suggests to us that a US recession is either imminent or now unfolding!

The impact of the credit crisis has apparently permeated to different sectors of the US economy from what we previously mentioned as signs of contamination in the commercial real estate to rising delinquencies in credit card, now globally to bond insurers (e.g Ambac Financials, FGIC Group, ACA Capital, French Natixis SA), reinsurers (e.g Europe’s Swiss Re), major mortgage lenders or “Government Sponsored Enterprises” (GSE’s) in Freddie Mac and Fannie Mae, Municipal Bonds (e.g. California’s downgrade) and even to rising incidences of default in US auto loans.

Mounting risks of losses from Australian and Japanese corporations loom on CDO downgrades, where recently major Japanese banks were reported to have accounted for ¥ 1.3 trillion yen or US $12 billion in US subprime exposure.

Even European banks have agreed to temporarily desist or suspend from trading on so-called “covered bonds”, or securities backed by mortgage or loans to public sector institutions (Bloomberg) `` to halt a slump that has closed the region's main source of financing for home lenders”.

Meanwhile, three month deposit yields in some Asian countries fell on contagion fears. This excerpt from Telegraph’s Ambrose Evans Pritchard (highlight mine),

`` The global credit crisis has hit Asia with a vengeance for the first time, triggering a massive flight to safety as investors across the region pull out of risky assets.

`` Yields on three-month deposits in China and Korea have plummeted to near 1pc in a spectacular fall over recent days, caused by panic withdrawals from money market funds and credit derivatives…

`` Korean and Chinese three-month yields have fallen from 4pc to 1pc in a matter of days in an eerie replay of events on Wall Street in late August when flight from banks and the US commercial paper markets caused yields on three-month Treasuries to falls at the fastest rate ever recorded. Asian investors appear to be opting for deposit accounts with government guarantees.

`` It is unclear what prompted this latest "heart attack" in the credit system, though rumours abound that Asian banks have yet to own up to their share of the expected $400bn to $500bn losses from the US mortgage debacle.”

Even sovereign debts appear to be stomped by the ongoing stampede out of risk assets, from Financial Times (highlight ours),

``Investors are shunning European government debt issued by countries other than Germany as worries about a global economic slowdown prompt a flight to safety within Europe.

``There is a strong sell-off in sovereign debt relative to [German] bunds, ranging from top-rated Spain to eastern Europe,” said Ciaran O’Hagan, strategist at SG CIB.

``Credit spreads, derivatives, and currencies are all taking a whack as part of the flight to quality.”

These developments include emerging market debts which this week suffered quite heavily. Curiously, while most of the damages to emerging Asian debt had been relative to domestic currency denominated issues, the Philippines appears to have been the least affected in both local and US dollar issues, based on the data from Asianbondsonline.org. Of course this is not to suggest that we are “better off” than the rest of the pack, as one week does not a trend make.